New type of banking system / bank required

Justin Collery

I am wondering why nobody has setup a deposit only bank in Ireland. This bank would operate on the principle that any money you lodge in it would not be loaned out but lodged into the ECB. You would get no interest on your money, but it is 100% secure, and we get bog all interest at the moment anyway. The bank itself would make money as the ECB pays interest on these deposits. The bank would keep this ECB interest.

Thinking about this further, why would a government not mandate that all banks taking deposits of say, less than €20k must be deposit only banks, and must lodge the money with the ECB. Call these "Deposit Banks", banks that do lending would be called "Lending Banks". Amounts larger than €20k could be put into banks that do lending if the owner wished, and they would then be getting interest for taking the risk, but by their being a distinction in the type of bank, this risk is apparent.

Such a system would greatly reduce possible shocks as banks could fail with no risk to general depoitors, and the government would also be isolated from the risk.

Lending banks could leverage (i.e. borrow) money from the ECB, say 10 times what they have put as security into the ECB. They could pay varing amounts of interest on this money based on when the money must be returned to the ECB. When they would have to return the money to the ECB would match the profile of their loans.

The net effect I believe would be the same amount of money going through the system, but the system would be more fracured, with each compoenent isolated from the other, and so it would be more stable.

In such a system, Anglo would have been "Lending Bank" and would have failed with no impact on the other banks.
AIB and BOI would probably have remained as deposit banks, would have had no loan books and so would not have needed a bail out.
Other "Lending Banks" would probably have surfaced to compete with Anglo, and they may or may not have gone bust, in either case it would not have mattered.

Comments please.
JC

Scofflaw

Somewhat similar, from a post of mine on another thread.

Banks aren't ordinary businesses - they usually can't be allowed to fail, so they shouldn't really be allowed to operate with a free hand at all.

At this stage, I'm not really convinced that the major banks should be allowed outside the hands of the state. The state is admittedly incompetent - that's shown by their failure to regulate them properly in the first place - but it's also unadventurous and risk-averse. Let minor banks handle the adventurous lending, and break them up the moment they reach a certain size. They're not normal businesses - why do we allow the to act like it?

The bigger banks there are your 'deposit banks', and the small ones are the 'lending banks'. No big lending banks - there's a size cap to their loan book. They can get as profitable as they like within that limit, but they can't exceed it, and the big banks are restricted to lending only on the most safety-conscious basis, established by statute.

cordially,
Scofflaw

ei.sdraob

@Scofflaw these issues were already solved once before, after the Great Depression, pitty these laws and the like were repealed directly contributing to this global crisis.
No need to reinvent the wheel.

The argument for preserving Glass–Steagall (as written in 1987):
1. Conflicts of interest characterize the granting of credit (that is to say, lending) and the use of credit (that is to say, investing) by the same entity, which led to abuses that originally produced the Act.
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

To ensure this doesn't happen again:
* split the banks into separate deposit, lending and investment banks
* create a eurozone wide deposit insurance scheme like they have in US, badly needed on this side of the pond, just to provide confidence
* make the deposit banks provide detailed accounts to the public, who can see for themselves how good/bad the bank is and shop around
* apply these rules only to the banks who have customers in the Republic, if the banks in the IFSC want to run global gambling operations let them provided they nor their branches/subsidiaries/parent are involved in customer deposits here or in eurozone.

ontour2

There certainly needs to be a lot more thought in to which products and services can be sold by which institutions. One of the assumptions of your argument is that the ECB is bulletproof, maybe it is but I know many people who bought shares in Irish banks thinking that they are bulletproof.

The need to address deposit security should also address some of the national funding issues. Anglo Irish Bank should have an unlimited deposit guarantee. The state is on the hook for the losses anyway, they might as well reduce the cost of debt financing by encouraging an influx of deposits. There are plenty of people out there sitting on the proceeds of house sales or large deposits as the wait for the property market to 'bottom out'. We need to change the perspective that the UK banks are the safe place to put the money to benefit the state finances instead.

ei.sdraob

Anglo Irish does have an unlimited deposit guarantee .
tho no large inflow of deposits, there is no confidence in this bank, and if you have alot of money saved you also realise that the states guarantee is a bluff, and if came **** to show the state wont be able to honour its guarantees.


They dont control the printing presses or other levers of economy, the ECB does, which brings me to your first sentence, ECB is a central bank with access to the printing presses and set eurozone wide policies, the other banks are not, huge difference.

ontour2

ei.sdraob wrote: »

Anglo Irish does have an unlimited deposit guarantee .

I didn't say that they do, I said that they should have it. Even if the government can't meet the guarantee, I am confident that the European institutions will bail out the country and honour the guarantee.

Your point about the ECB and the printing presses in very true. If the Irish banks did not have access to the high multiples of reserves that they got during the boom years we would be in a lot less trouble now so I am not hugely convinced that ECB / Int'l banks etc. did not pour petrol on the fire during the boom years. We can't rely on Europe to regulate, we need to take responsibility for protecting Ireland from a repeat in the mistakes in financial services.

ei.sdraob

ontour2 wrote: »

I didn't say that they do, I said that they should have it. Even if the government can't meet the guarantee, I am confident that the European institutions will bail out the country and honour the guarantee.

see my first post in this thread

me wrote:

* create a eurozone wide deposit insurance scheme like they have in US, badly needed on this side of the pond, just to provide confidence

ontour2 wrote: »

Your point about the ECB and the printing presses in very true. If the Irish banks did not have access to the high multiples of reserves that they got during the boom years we would be in a lot less trouble now so I am not hugely convinced that ECB / Int'l banks etc. did not pour petrol on the fire during the boom years. We can't rely on Europe to regulate, we need to take responsibility for protecting Ireland from a repeat in the mistakes in financial services.

Isolation and having own currency did not stop the likes of Iceland going boom.
We are part of a single currency union, some of the solutions will have to come from Europe.

ontour2

ei.sdraob wrote: »

Isolation and having own currency did not stop the likes of Iceland going boom.
We are part of a single currency union, some of the solutions will have to come from Europe.

As with most things there are two sides to every story. I don't dismiss the many benefits that we have gained from Euro membership but that does not stop me being concerned about what will happen to ECB/EURIBOR interest rates when France and Germany start to heat up and inflation rises. The fact that Ireland is lagging behind in growth will not drive interest rate policy. We boomed on the back of cheap European credit due to depressed economic conditions in the main EU economies. If our success is based on the main EU economies doing badly you have to be concerned about our future economic stability. Fear of contagion and the relatively small size of our economy are Ireland's saving grace.

ei.sdraob

ontour2 wrote: »

As with most things there are two sides to every story. I don't dismiss the many benefits that we have gained from Euro membership but that does not stop me being concerned about what will happen to ECB/EURIBOR interest rates when France and Germany start to heat up and inflation rises. The fact that Ireland is lagging behind in growth will not drive interest rate policy. We boomed on the back of cheap European credit due to depressed economic conditions in the main EU economies. If our success is based on the main EU economies doing badly you have to be concerned about our future economic stability. Fear of contagion and the relatively small size of our economy are Ireland's saving grace.

Blaming all the problems on cheap credit is way too simplistic, I already pointed out at start of the thread that our issues could be traced back to the 90s when certain depression era laws were removed.

To give an example. If a bank offers you cheap credit (lets say 100,000 at 1%) it is not the fault of the bank that you blow the money on hookers and coke instead of starting a business as you promised.

Scarab80

jcollery wrote: »

I am wondering why nobody has setup a deposit only bank in Ireland. This bank would operate on the principle that any money you lodge in it would not be loaned out but lodged into the ECB. You would get no interest on your money, but it is 100% secure, and we get bog all interest at the moment anyway. The bank itself would make money as the ECB pays interest on these deposits. The bank would keep this ECB interest.

Thinking about this further, why would a government not mandate that all banks taking deposits of say, less than €20k must be deposit only banks, and must lodge the money with the ECB. Call these "Deposit Banks", banks that do lending would be called "Lending Banks". Amounts larger than €20k could be put into banks that do lending if the owner wished, and they would then be getting interest for taking the risk, but by their being a distinction in the type of bank, this risk is apparent.

Such a system would greatly reduce possible shocks as banks could fail with no risk to general depoitors, and the government would also be isolated from the risk.

Lending banks could leverage (i.e. borrow) money from the ECB, say 10 times what they have put as security into the ECB. They could pay varing amounts of interest on this money based on when the money must be returned to the ECB. When they would have to return the money to the ECB would match the profile of their loans.

The net effect I believe would be the same amount of money going through the system, but the system would be more fracured, with each compoenent isolated from the other, and so it would be more stable.

In such a system, Anglo would have been "Lending Bank" and would have failed with no impact on the other banks.
AIB and BOI would probably have remained as deposit banks, would have had no loan books and so would not have needed a bail out.
Other "Lending Banks" would probably have surfaced to compete with Anglo, and they may or may not have gone bust, in either case it would not have mattered.

Comments please.
JC

Your solution just pushes the problem up a level into the ECB bank. If there was a massive euro wide recession and loans were defaulted on all over europe together with customers trying to withdraw their deposits then the ECB would face the same liquidity or solvency issues as any bank. Their backstop is that they can create money ex-nihlio however the result would be the same, instead of you losing some of the nominal amount of your deposit your deposit is reduced by a denegration in the purchasing power of the currency.

I had posted this before as a possible solution......

IMO the only way to ensure that the state is never again required to intervene in another bank bailout is to recognise the reality of the banking system. So long as you have long term loans funded by short term or indeed on demand funding the possibility of another bank run is always possible and given enough time inevitable.

Consider this proposal,

(1) Separate banks lending and retail/business services sections.

- Retail and business services will include all demand deposits as liabilities and cash as it's assets, the cash will not be invested but will be held by the banks as custodian. The banks will charge the demand depositers for the costs associated with holding this cash, i.e. security costs, insurance costs and will charge customers for services provided such as an ATM network. Money held on demand deposit will therefore have a negative rate of return.

- Banks will no longer engage in direct lending but will instead act as ratings agencies. If you want a loan you go to your local bank and go through the loan application procedures as normal however instead of being approved for a loan you are issued with a credit rating for that loan.

- Banks can also act as debt recovery agencies.

(2) Create a primary and secondary market for lending along the lines of Zopa. As a prospective borrower you take your credit rating received from the bank and place an offer on the primary market, prospective lenders looking for a return will also bid on this market. Once funds are matched a bond is issued for the term of the loan at a particular interest rate (fixed or floating). To spread the effect of possible bad debt losses, bonds could be issued in batches - for example AA Residential Mortgage bond maturing September 2030. Similarly lenders can manage the risk/return they want to receive by diversifying and buying bonds relating to specific sectors with specfic maturities and credit rating.

Now not too many people would be prepared to drop their capital on a mortgage with no access to it for 30 years, so a secondary market must be created where the bonds issued on the primary market can be bought and sold. This further allows investors to invest in whatever part of the yield curve they desire.

With money held on demand producing a negative rate of return, customers will be incentivised to keep their money in bonds, and sell bonds on the secondary markets and transfer to their demand account as it is needed.

(3) The banks would now compete on the basis of value and cost of services provided in the retail sector and on the basis of their ability to correctly price risk and provide an effective marketplace and bond products in the lending sector.

(4) Problems with this kind of system are
- How to transfer from our current system to this maturity matched system
- If too much money continues to be held on demand this can have a deflationary effect on the economy.
- Is the time and cost involved in managing money worth it or is it better to let the banks manage your money as per current system*
- Are Joe and Mary Bloggs knowledgeable or interested enough to operate such a system*

*I believe these concerns could be addressed by the emergence of companies who would manage your money on your behalf.

(5) In the event of another asset bubble with high levels of default the cost would be borne by those who took the decision to lend and the world would just keep rolling on.

(6) Central banking authorities can maintain macro-economic control by purchasing bonds in the secondary markets as they do now.

Justin Collery

@Scarab80

Brilliant. Actually, what you are proposing is so similar to what I was saying as to be almost the same. You suggest holding the money in the bank. I suggest lodging it with the ECB to get some interest. Holding physical cash is expensive, I suggest placing it with the ECB is more effecient.

I guess from a customers point of view the only practical problem is that we like to deal with one entity for our banking needs. This system would make us deal with 3 or 4 different companies to manage our finances.

Could the Irish regulator impoe such rules in Ireland unilaterally given we are in the Euro?

johnnyskeleton

I think you have a misconeption about why banks pay interest.

Why should I put my money in a bank earning no interest and which offers no credit or personal banking facilities when I can just keep it in cash?

If security is your concern, keeping it in a safe mounted into the wall/floor at home is probably just as safe as a bank.

Also, while I accept that I am not too clear on the ins and outs of ECB policy, my understanding was that the only deposits that they offered were overnight deposits (i.e. short term for interbank transfers) and emergency depositing of loans due to the financial crisis.

I don't think that a bank can simply lodge all its money in the ECB. What if every bank in Europe did this trick, how would the ECB get the money to pay all this interest other than loaning it out to the lending banks. Now, if they did loan it out to the lending banks, what is the point of getting the ECB involved at all as it is just a messier way of separating the deposits and lending but keeping them intertwined where it really counts (much like the proposed solution for anglo).

But even if the ECB did allow such lodgements, would the rate paid by the ECB be enough to cover the running costs of such a bank?

Scarab80

jcollery wrote: »

@Scarab80

Brilliant. Actually, what you are proposing is so similar to what I was saying as to be almost the same. You suggest holding the money in the bank. I suggest lodging it with the ECB to get some interest. Holding physical cash is expensive, I suggest placing it with the ECB is more effecient.

In your suggestion all deposits are lodged with the ECB, the ECB then loans this money out to lending banks, hence they earn interest on their loans to lending banks which they are able to pass on to depositers. I am saying that the deposit money, whether held by banks or central banks does not get redistrbuted but is held as excess reserves (or even by gold - though you are then reliant on gold appreciating against inflation and in line with the euro - which doesn't happen), this money is not put at risk therefore earns no interest. Physical cash reserves do not need to be held, numbers on a computer is sufficient, the amount of physical cash in existence is simply a subset of this figure which is needed for daily retail cash transactions.

Further my suggestion allows individuals to decide on their own risk profile rather than letting banks, be they retail or central, decide that for them. The advantage of your suggestion is that europe wide risk is spread amongst the capital of european citizens.

jcollery wrote: »

I guess from a customers point of view the only practical problem is that we like to deal with one entity for our banking needs. This system would make us deal with 3 or 4 different companies to manage our finances.

You would keep your bank as usual for all your everyday banking needs, if you want a loan you go to a credit assessor the same as you do now - the only difference being that you get a rating instead of approval. The ratings section of the bank need not move from under the same roof as the retail bank.

The only additional step is a web and/or broker OTC based market where you can seek credit or lend money. The difference between primary and secondary markets would be marginal and would be incorporated in the same system.

jcollery wrote: »

Could the Irish regulator impoe such rules in Ireland unilaterally given we are in the Euro?

No idea, but given that so much of our banking system is being supported by the ECB at the moment such a move now would definitely require their approval. Although, it's all pie in the sky stuff, never gonna happen

nesf

ei.sdraob wrote: »

make the deposit banks provide detailed accounts to the public, who can see for themselves how good/bad the bank is and shop around

The general public will not be able to judge a bank based on its accounts. Actually baring those with economic, financial or accounting training, very, very few will be able to judge a bank based on detailed accounts. They'll have to go on the advice of a third party and that brings with it a whole host of problems since the industry, and those dependent on it, will have a very strong incentive to talk up the state of the banks.

nesf

Scofflaw wrote: »

At this stage, I'm not really convinced that the major banks should be allowed outside the hands of the state.

A number of independent banks are essential to foster competition and to drive down interest rates for consumers and business. Also having one party in charge of doling out credit discourages competition in other sectors as it's in the best interests of the single creditor to foster one successful industry leader than it is to fund challengers to that leader which just brings us more problems again. And that's before we even think about the problem corruption will play with State employees having control over such a crucial thing as the source of credit in a society.

A state owned financial sector looks attractive but really it just brings a whole host of problems as severe or even more severe than the prospect of a banking crash once a generation. Well regulated independent private banks is a far better way to go than a State owned model. Similar to how competition in the electricity market is a better way to go etc.

Scofflaw

nesf wrote: »

A number of independent banks are essential to foster competition and to drive down interest rates for consumers and business. Also having one party in charge of doling out credit discourages competition in other sectors as it's in the best interests of the single creditor to foster one successful industry leader than it is to fund challengers to that leader which just brings us more problems again. And that's before we even think about the problem corruption will play with State employees having control over such a crucial thing as the source of credit in a society.

That's why I suggested small lending banks alongside the bigger state-owned banks - and lending by the bigger banks, but only on very conservative terms, directed by statute.

nesf wrote: »

A state owned financial sector looks attractive but really it just brings a whole host of problems as severe or even more severe than the prospect of a banking crash once a generation. Well regulated independent private banks is a far better way to go than a State owned model. Similar to how competition in the electricity market is a better way to go etc.

Oh, I agree - but the problem seems to be that the banks invariably escape their regulatory oversight. Banking seems to operate in a very pro-cyclic way - loose lending policies in good times, which tend to encourage bubbles, and then a sudden tightening in recessions, which tend to exacerbate those in turn. Currently, it would be very hard to get a loan for a good idea - five years ago it was easy to get a loan without any idea at all.

cordially,
Scofflaw

Scarab80

Scofflaw wrote: »

Oh, I agree - but the problem seems to be that the banks invariably escape their regulatory oversight. Banking seems to operate in a very pro-cyclic way - loose lending policies in good times, which tend to encourage bubbles, and then a sudden tightening in recessions, which tend to exacerbate those in turn. Currently, it would be very hard to get a loan for a good idea - five years ago it was easy to get a loan without any idea at all.

cordially,
Scofflaw

I don't think it's just banks that operate in a pro-cyclic manner, it's economies or more precisely people. In good times funding from all sources is easy to come by, be it banks, IPO's, bonds etc. Households increase their consumption and often fuel current spending via debt. The opposite happens in a recession, hence the necessity of central banks to try and maintain a stable economy.

There is no reason to think that state controlled banks would not act in the same pro-cyclical manner that private banks do given that the government, since the introduction of the euro, have failed monumentally to provide fiscal macro-economic controls in the absense of a domestic central bank.

Justin Collery

Scarab80 wrote: »

In your suggestion all deposits are lodged with the ECB, the ECB then loans this money out to lending banks, hence they earn interest on their loans to lending banks which they are able to pass on to depositers.

'tis a little late but there are actually some more fundamental differences. I really like your plan, I must look at merging them, but my plan solves an important issue, the amount of liquidity in the system. Think of some sort of ideal bank today:

Deposits - €100
Loans - €100
Bonds / Shareholders capital (basically risk capital) - €12

Under the new scheme, you would imagine that those who have their money on deposit right now would still do so. The only cash available to lend out would be the €12 risk capital. But today we have €100, not €12 out on loan so we have a liquidity problem. To ensure the same amount of liquidity as we currently have, this €12 needs to be multiplied. Thats why the deposits should be lodged with the ECB, and also why the ECB will give those who put up risk capital about 10 times the money they put up to loan out.

Scarab80 wrote: »

Although, it's all pie in the sky stuff, never gonna happen

There's a 95% chance you are right, normally. Right now there is probably a 94% chance you are right. We're heading for an interesting 12 months where anything could happen, maybe even a change in the way banks operate.

You can't predict black swan events, who would have said 3 years ago we would have more than half the banking system nationalised.

ei.sdraob

nesf wrote: »

The general public will not be able to judge a bank based on its accounts. Actually baring those with economic, financial or accounting training, very, very few will be able to judge a bank based on detailed accounts. They'll have to go on the advice of a third party and that brings with it a whole host of problems since the industry, and those dependent on it, will have a very strong incentive to talk up the state of the banks.

When you have alot of money to deposit, you would pay more attention where your money is going, information (the more is better) would help you to save your money more wisely, saving is a form of investing and when it comes to investing information is key

there is another reason for calling for more transparency, would Anglo have been able to move billions about as they did if there where more eyes on the figures

Scarab80

jcollery wrote: »

Under the new scheme, you would imagine that those who have their money on deposit right now would still do so.

No, if that happens then my idea would fail completely and we would have a massive deflationary spiral - it is undoubtedly the biggest problem in my idea and I probably should have highlighted it more than I did.

It relys on this line

With money held on demand producing a negative rate of return, customers will be incentivised to keep their money in bonds, and sell bonds on the secondary markets and transfer to their demand account as it is needed.

If the reality of banking is realised, that if you want 100% security you must pay for it along with all of your other banking services which at the moment are subsidised to almost 100% by letting the bank use your demand deposits for lending, then the rational depositer should seek to offset these costs by minimising the amount held on deposit and using surplus savings to obtain an interest return on the lending market.

If this market were sufficiently liquid transferring to and from it should be as easy as transferring funds from your deposit account to your current account.

nesf

Scofflaw wrote: »

That's why I suggested small lending banks alongside the bigger state-owned banks - and lending by the bigger banks, but only on very conservative terms, directed by statute.



Oh, I agree - but the problem seems to be that the banks invariably escape their regulatory oversight. Banking seems to operate in a very pro-cyclic way - loose lending policies in good times, which tend to encourage bubbles, and then a sudden tightening in recessions, which tend to exacerbate those in turn. Currently, it would be very hard to get a loan for a good idea - five years ago it was easy to get a loan without any idea at all.

cordially,
Scofflaw

I agree. That said, the new Basil Regulations are being specifically targeted at making the banks less pro-cyclical. It's impossible to remove the pro-cyclical element but things like forcing them to take on bigger reserves during the good times can only help.

At the core though is the need for a well financed, trained and active set of financial regulators (who essentially are sceptical and cynical about the banks' ability to regulate and monitor themselves) who have the power to go in and stop banks from taking certain actions during the good times. A very difficult thing to achieve but definitely something worth striving for.